Interest Rate and
Money Market Problems
1. If the real interest rate is 2.5% and inflation is expected to be 4%, according to the Fisher effect what should be the nominal interest rate?
Answer: 6.60%
2. Assume that the Fisher effect is true. What is the market’s expectation for inflation if the nominal rate is 5% and the real interest rate is 3%?
Answer: 1.94%
3. If the nominal interest rate is 5.5% and you expect the inflation rate to be 2.5%, what is the real interest rate according to the Fisher effect?
Answer: 2.93%
4. A 7-year bond issued by Pern Corp. has an interest rate of 7.25%. A 7-year U.S. Treasury note has an interest rate of 4.75%. What is the default risk premium for the Pern Corp. bond?
Answer: 2.50%
5. Yoknapatawpha County Mississippi is considering issuing bonds to build the B. Compson memorial natatorium. A bond issued by Snopes Inc., which has the same maturity and default risk as the bonds the county is considering, has a yield to maturity of 9.53%. If the marginal tax rate is 44.1%, what yield to maturity will the county have to pay for its bonds?
Answer: 5.33%
6. Franklin Mills Ohio has a bond outstanding with an interest rate of 4.35%. If the marginal tax rate is 45.5%, what would be the interest rate on a corporate bond with the same term and default risk?
Answer: 7.98%
7. A municipal bond has an interest rate of 5%. An equivalent corporate bond has an interest rate of 8%. What is the marginal tax rate?
Answer: 37.5%
8. Currently the 1-year rate is 4% and the 2-year rate is 3.5%. If the unbiased expectations theory of term structure is correct, what does the market expect the 1-year rate to be one year from now?
Answer: 3.00%
9. Currently the 1-year rate is 4%. You believe that one year from today the 1-year rate will be 4.5%. Under the unbiased expectations theory of term structure, what must the 2-year rate be today?
Answer: 4.25%
10. A Treasury bill with 125 days to maturity has a face amount of $10,000. It currently sells at a price of $9,880.14.
Answer: 3.45%
Answer: 3.54%
11. A $10,000 face value Treasury bill with 175 days to maturity has a discount yield of 4.21%.
Answer: $9,795.33
Answer: 4.36%
12. A $10,000 face value discount security with 75 days to maturity has a bond equivalent yield of 3.52%.
Answer: $9,928.19
Answer: 3.45%
13. A $10,000 face value Treasury bill sells at a price of $9,912.74. If the quoted discount yield on this security is 3.452%, what how many days is it until this bill matures?
Answer: 91 days